1

The Evolving Air Transport Industry

If you want to be a millionaire, start with a billion dollars and open an airline. Soon enough you will
be a millionaire.

Sir Richard Branson, Founder, Virgin Atlantic Airways

As the comment above implies, in the last 30 years the airline industry’s
earnings have fluctuated wildly (mostly downward). As the industry fluctuated
a series of consolidations and bankruptcies began to occur. New carriers such
as JetBlue and AirTran in the US, EasyJet and Ryanair in Europe, Gol and
Volaris in Latin America and a few others entered the industry, but many others
such as Eastern, Pan Am, and Midway declared bankruptcy and ultimately
ceased operations. Other carriers like Delta and Northwest, and United and
Continental survived bankruptcy but merged post-bankruptcy, further
consolidating the industry. In more recent times, a new airline paradigm called
low-cost carriers (LCCs) were created to accommodate the economic changes
that were happening. These LCCs have rapidly gained market share and
currently hold approximately 24 percent of global capacity. In response to the
LCCs, legacy carriers trimmed services and boosted ancillary means of
revenue generation.
With relatively minimal profit margins, the financial condition of the
aviation industry is highly dependent on the global economic conditions.
During times of economic boom, profits soar and in times of distress carriers
are forced to cut back capacity. The purpose of this chapter is to describe the
evolution of the air transport industry including airlines and airports. The
topics include the following:

¢ The Airline Industry

¢ Financial Condition of the Airline Industry
¢ Consolidation and Bankruptcies
* Factors Affecting World Air Traffic Growth
¢ Economic Impact of Air Transport Industry
— Direct Impact
 — Indirect Impact
— Induced Impact
— Total Impact
¢ Outlook for the Air Transport Industry
¢ Summary
¢ Discussion Questions

THE AIRLINE INDUSTRY

It is estimated that airline travel will nearly double over the next 20 years. The
number of passengers in the US will grow from 732 million in 2012 to 1.2
billion in 2032. Since the US Airline Deregulation Act of 1978, the US airline
industry (and to a certain extent the global airline industry) has been
characterized by volatility. This volatility produces airline bankruptcies, large
layoffs or employee pay cuts, loss of shareholder wealth, and great uncertainty
in the market. Periods of high revenues are followed by periods of economic
drought. The most recent economic “troughs” followed the September 11
terrorist attacks in 2001 and the economic recessions of 2008 and 2009. Prior
to deregulation, the airline industry was relatively stable with minimal losses
and healthy profits; however, it was also clear that this state of affairs was due
mainly to government regulation that virtually eliminated any meaningful
competition between airlines and certainly prevented new competitors from
entering the market. The biggest loser in all of this was the passenger who had
to pay ticket prices that were set to cover average airline costs with no
competitive discounts permitted. Therefore, while deregulation may seemingly
have caused huge financial losses, it also reflected the fact that airlines were
faced with their first bout of meaningful competition and some did not measure
up. On the other hand, deregulation also opened up the opportunity for some
airlines, such as Southwest Airlines and Ryanair, to post some of the greatest
profits in the history of the industry. Figure 1.1 graphically displays this trend
of volatile profitability for the global airline industry.

“People Express is clearly the archetypical deregulation success story and the most
spectacular of my babies. It is the case that makes me the proudest.”
Alfred Kahn, Professor of Political Economy, Cornell University
 The major reason why the deregulation of the US airline industry had such
a large impact on the global airline industry is that the North American airline
industry has historically been the most dominant player in the global aviation
industry. Table 1.1 shows that although the North American market still
currently holds the distinction of being the largest market in terms of aircraft
movements (34.8 percent), it has lost market share for passengers and cargo. In
2011, the European region surpassed North America in terms of passengers
with 30.6 percent of global passenger market, with Asia-Pacific closing the
gap with 25.4 percent share of the market. This growth has been a direct result
of the explosive economic expansion in those regions, particularly China and
India (expected to continue at 6.7 percent over the next 20 years).' Boeing and
Airbus market forecasts both point out that the Asia-Pacific region is expected
to surpass the North American market in the next 20 years in absolute terms of
growth and market share with over half of the world’s air traffic growth driven
by travel to, from, or within the Asia-Pacific region.
It is interesting to note that in terms of international passengers, both the
Asia-Pacific and Europe markets have far surpassed North America (Table
1.2). Europe’s dominance in international air transportation is mainly a result
of its historical ties to former colonial countries and its relatively small
geographical area. Because of this small area and significant government
support for other surface transportation (mainly railroads), most of the
domestic aviation industries in Europe are relatively small; therefore,
European airlines survive on international travel. The growth in economies of
Eastern Europe will also undoubtedly increase its share of international travel.
 22000

17000 -

12000

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Figure 1.1 World Airline Operating Profits

Source: Compiled by Authors

Table 1.1 World Airlines Passenger and Cargo Traffic (2011)

Movements % Change | Passengers "o Change | Cargo o Change

Africa 2,223,682 (1.0) | 133,558,845 (5.9) | 1,453,797 03

Asia-Pacific 10,636, 150 5.2 | 1,254,517,321 5.7 | 30,207,926 (1.5)

Europe 17,965,635. 3.4 | 1,508,974,011 7.1 | 17,376,134 12

Latin American | 5,829,835 5.5 | 388,084,263 8.6 | 4,706,559 6.1
Middle East 1,558,943 2.9 | 178,862,214 84 | 5,603,482 1.6
North America | 25,911,039 (0.7) | 1467,455,424 1.8 | 24,695,659 (7)

Total 74,454,642 2.0 | 4,931,251,978 4.9 | 84,043,557 (0.1)

Source: Airports Council International

Another trend in the air transportation industry is the growth and expansion
of the cargo industry. Table 1.1 and Table 1.2 quote cargo (in metric tons) for
each region and for international cargo. The Asia-Pacific region is the
dominant region for cargo (especially international cargo) as it currently holds
a 40 percent share of the international cargo market, even with a 3 percent
decline in 2011. Much of this growth is a result of China’s burgeoning
economy and the large and growing amount of exports that come from the
region.
Table 1.2 International Passengers and Cargo Traffic (2011)

Passengers “o Change Cargo % Change

Africa $1,372,791 (9.4) 1.300.233 5.9

Asia-Pacific 435.033.610 6.3 20,993,996 (3.0)

| Europe | 1,091,153,140 8.0 13,218,501 1.8

Latin Amencan 109,337,990 fd 3,216,553 6.2

Mictclle East 156,149,157 5.6 5,391,651 1.8

| North America 203,780,170 4.2 9,307,266 (0.1)

Total 2,100,048,858 6.4 53,428,230 (0.1)

Source: Airports Council International

Another way of looking at the global distribution of air transportation is the

number of in-service aircraft. Table 1.3 divides aircraft into two categories
based on the aircraft’s age: new and middle, or old. While the North American
market contains the highest number of commercial aircraft, it also contains a
relatively high percentage of mid-generation and older aircraft (41 percent).
For aircraft manufacturers, this is attractive as many of these older aircraft will
have to be replaced in the coming years. Europe, on the other hand, does not
have very many mid-generation to older aircraft (25 percent) as this is
probably a result of the stringent noise regulations implemented by the
European Community that banned many older generation aircraft. Finally, some
correlation can be made between the number of new aircraft and the region’s
economic growth. For example, Africa has the highest percentages of older
aircraft (44 percent) while more prosperous regions like Europe and Asia
have low ratios (25 percent and 21 percent respectively).

Table 1.3 Aircraft in Service by Region (2010)

 New Mid Old

North America 50%, 41%

Europe 75%, 25%

Asia 7O%, 21%

Latin America 67%

Africa

Middle East F2t6

World 69% | 27% 40

Source: Compiled by authors using Boeing 2011 market forecast

A final method to analyze the composition of the air transport industry is to

analyze traffic data on an airport-by-airport basis. Tables 1.4 and 1.5 provide
a list of the top 15 airports in terms of total passengers, total international
passengers, and total cargo volume. The rankings of the top airports mirror the
distribution of passengers by regions as evidenced by the two largest airports
in terms of passengers. Since North America is the second largest market in
terms of passengers, it is not surprising that Atlanta is the top airport.
Conversely, since Europe is the top region for international passengers, it
should come as no surprise that the top two airports, in terms of international
passengers, are in Europe. Also, many of the airports on the international
passenger traffic list are airports located in countries that have small or non-
existent domestic air travel markets. Similar to the airline market, the Asia-
Pacific region is experiencing tremendous growth in airports. For example,
Beijing Capital International Airport has seen a more than 50 percent increase
in passenger traffic since 2006. Several Asian airports that were already on
the list saw phenomenal increases in passenger traffic from 2010 to 2011; most
notably, Jakarta saw a 19.3 percent increase in passenger traffic.
Much of the airport development in the Asia-Pacific region is still taking
place in China and India, though there are notable projects in Vietnam, the
Philippines, and Indonesia. The division of airports by region in terms of cargo
volume is not as clear cut, but both North America and Asia-Pacific airports
are well represented in the top 15. Hong Kong has replaced Memphis as the
busiest cargo airport in the world. In the Asia-Pacific region, the large amount
of export trade has spurred cargo growth, especially in Hong Kong and
Shanghai (numbers 1 and 3 respectively).

Table 1.4 Total Passenger Traffic

Total Passenger Traffic International Passenger Traffic

Rank | Airport Total % Chg | Rank | Airport Total % Chg

I Atlanta (ATL) 92,305,860 | 3.4 | London (LHR) 64,687,737 | 6.20

2 Beijing (PEK) 77,403,668 | 4.7 2 Paris (CDG) 55,674,880 | 4.80

3 London (LHR) 69,433,565 | 5.4 3 Hong Kong (HKG) 52,749,262 | 6.00

4 Chicago (ORD) 66,501,023 | (0.5) 4 Dubai (DXB) 50,192,013 | $40

5 Tokyo (HND) 62,263,025 | (2.9) 5 Amsterdam (AMS) 49,680,283 | 10.10

6 Los Angeles (LAX) 61F48,449 | 48 6 Frankfurt (FRUA) 49,477,184 | 6.90

7 Paris (CDN) 60,970,551 45 7 Singapore (SIN) 45,429,263 | 11.00

8 Dallas/Fort Worth (DFW) | 57,806,152 | 1.6 8 Bangkok (BKK) 35,009,002 | 11.40

9 Frankfurt (FRA) 56,436,255 | 6.5 9 Seoul-Incheon (ICN) 4537845 | 4.80

10 Hong Kong (HKG) 53,314,213 | 5.9 10 Madrid (MAD) 32,449,857 | 4.70

11 Denver (DEN) 52,699,298 | 0.0 i London (LGW) 29,923,391 | 7.50

12 Jakarta (CGK) 52,446,618 1h3 12 Munich (MUC) 27,879,045 | 10.10

13 Dubai (DXB) 50,977,960 | 8.1 13 Tokyo (NRT) 26,331,010 | (18.10)

i4 Amsterdam (AMS) 49,754,910 | 101 14 Kuala Lumpur (KUL) | 25,915,723 | 10.70

15 Madrid (MAD) 49,644,302 | (0.4) 15 Rome (FCO) 24,448,925 | 5.00

Source: Compiled by authors using Airports Council International

Data ison the 12 months preceding and including December 2011

Table 1.5 Cargo Traffic at Major International Airports

 Rank Airport Cargo (metric tonnes) “oe Change

l Hong Kong (HKG) 3,968,397 (4.7)

2 Memphis (MEM) 3,916,535

3 Shanghai (PVG) 3,103,030 (4.3)

4 Anchorage (ANC) 2,625,201 0.5

5 Incheon (ICN) Zao. 222 (5.4)

6 Dubai (DXB) 2,269,768 _

7 Frankfurt (FRA) 2,215,181 (2.6)

5 Louisville (SDF) 2,187,766 LQ

o Paris (CDG) 2,095,773 (4.0)

10 Tokyo (NRT) 1,945,110 (10.3)

1] Singapore (SIN) 1,898,850) A]

12 Miami (MIA) 1,840,231 0.2

13 Los Angeles (LAX) 1,688,351 (7.2)

14 Beijing (PER) 1,668,751 77

15 Taipei (TPE) 1,627,461 (7.9)

Source: Compiled by authors using Airports Council International

Data is on the 12 months preceding and including December 2011

FINANCIAL CONDITION OF THE AIRLINE INDUSTRY

I don’t think JetBlue has a better chance of being profitable than 100 other predecessors with new
airplanes, new employees, low fares, all touchy-feely... all of them are losers. Most of these guys are
smoking ragweed.

Gordon Bethune, CEO Continental Airlines, June 2002

The US Airline Deregulation Act of 1978 dramatically changed the global

financial condition of the airline industry. Soon after the US, other countries
also began to deregulate their own industries. And, as mentioned earlier, prior
to 1978, the industry was relatively stable based mainly on the government’s
enforcement of non-competitive regulation and pricing. In the post-deregulation
era, the industry took on the more cyclical nature of a competitive industry,
where periods of robust financial profitability could be followed by periods of
severe economic distress. Like other competitive industries, the financial
condition of the airline industry is highly related to economic growth, so it is
therefore not surprising that the airline industry suffered when the economy
stalled.
In the early 1980s, shortly after US deregulation, the airline industry
suffered a minor crisis as the economy slowed and competition soared. More
specifically, the US domestic industry experienced overcapacity, as the many
new airlines that were formed out of deregulation either went bankrupt or
merged with other carriers. The result was four years of global net losses for
the industry, largely based on the situation in the US. A similar situation
occurred in the early 1990s as the economy once again experienced a
downturn, but this downturn was aggravated by political uncertainty from the
first Gulf War and increased fuel costs.
While the early parts of each decade following deregulation have proved
to be troublesome for the airline industry, the industry has recovered to post
record short-run profits in the late 1980s and again in the late 1990s. This was
partly as a result of the overall improvement in the global economy, but
financial distress and competition also caused airlines to be more innovative
and conscious of controlling costs. Tools such as revenue management and
frequent flier programs were created and developed during these periods.
Additionally, technological innovations allowed the airlines to improve their
profit margins. For example, simpler cockpit design has been able to reduce
the number of flight crewmembers, better engine design has reduced the
number of engines required to fly long distances, and fuel costs have been
reduced with more fuel-efficient engines. All of these technologies have
enabled airlines to reduce their costs and/or increase revenue. A more recent
technological innovation has been e-ticketing, which allows airlines to reduce
their ticket distribution costs.
The post-deregulation airline profitability cycle continued into the new
century with the global industry experiencing its worst downturn in the history
of commercial aviation. While the September 11, 2001 terrorist attacks were
the proximate cause of the global airline industry’s financial problems, the root
cause of the problem was a slowing economy that reduced passenger yields.
Added to this were rising jet fuel costs, increased airline operating costs
stemming from overcapacity in domestic markets, and increased security costs
at commercial airports. As a point in fact, the airline industry was in trouble
before the September 11 disaster, with many airlines losing money and with no
significant initiatives to reduce costs and increase productivity. The result of
this situation was net losses for the entire airline industry from 2001 to 2005
until an economic resurgence returned the industry to profitability in 2006 and
2007. These profits were short lived however, as 2008 brought about arguably
the worst year in the history of commercial aviation, with a $26.1 billion net
loss as shown in Table 1.6. Again, an overall economic recovery has
somewhat stabilized the industry’s return to profitability in 2010 and 2011.
However, the road to recovery has been slow for the airline industry as a
result of political instability (in various parts of the world), rising fuel prices,
and persistent competition between network and LCCs. This situation has been
most evident in the North American market where the high-profile bankruptcies
of US Airways, United, Delta, Northwest, and now American have highlighted
the increasing effects of fierce competition from lower-cost airlines and the
bloated cost structures of the more traditional airlines. Globally, we see some
different patterns. Table 1.7 presents the international air transport market’s net
profits based on the different geographical regions. After a year of severe
losses across the board, except for Asia-Pacific and Latin America carriers in
2009, the industry recovered in 2010. The Asian-Pacific carriers also enjoyed
the highest level of profitability followed by North America for 2011.

Table 1.6 Scheduled Airlines’ Financial Performance

 2003 2004 2005 2006 2007 2008 2009 2010 2011F
REVENUES, $ billion 322. 379 403 465 510 570 47H SAP 596
Passenger 249 294 323 365 399 44 a74 425 469
Cargo 40 47 48 Bo So 63 48 66 66

Other 33 38 42 47 52 63 54 56 61
Sched. passengers, millions 1349 2,064 2,211 2,325 2,518 2,507 2.479 2,681 2,840
Freight tonnes, millions 38 41 42 45 47 45 41 46 46
Passenger yield, ‘% 24 2.6 27 78 27 95 (14.0) 6.1 4.0
Cargo yield % 2.0 7A 24 54 5.5 74 (14.2) 15.0 -
EXPENSES, § billion 323 376 409 450 490 571 474 525 583
Fuel 44 65 91 117 135 189 125 139 178

Crude oil price, Brent, 5/b 29 38 55 65 73 99 62 79 112

Jet kerosene price, $/b 35 50 71 2 90 127 71 a1 128
Non-fuel 279 311 318 333 355 382 49 386 405
Cents per ATK (nen-fuel cost) 39 40 39 39 39 42 40 42 41

Breakeven weight load factor, "bs 61] 619 620 612 609 632 623 63.1 63.1
Weight load factor achieved, “i. 60.8 62.5 62.6 63.3 6344 63.1 62.6 65.7 O45

Passenger load factor achieved, ‘% 715 7a 749 76.1 ea 76.0 76.0 784 782

OPERATING PROFIT, § billion (1.4) a5 44 150 19.9 (1.1) 19 «6217 )06=— 132
oy Margin (O04) 0.9 1.1 aon 3.9 (0.2) 04 4.0 2

NET PROFIT, $ billion (7.5) (5.6) (4.1) 5.0 14.7 (26.1) (4.6) 15.8 69
oo margin (2.3) (1.5) (1.0) 1.1 2.9 (4.6) (1.0) 29 12

Source: Compiled by authors from [CAO and LATA airline financial data

Table 1.7 Financial Performance of Airline Industry

Industry Net Profits: US$ Billion

2009 2010 2011

Global (4.6) 15.8 6.9

North America (2.7) 41 2.0
Europe (4.3) 19 1.0
Asia-Pacific 2.6 8.0 3:3

Middle East (0.6) 0.0 04

Latin America 0.5 09 02

Africa (0.1) 0.1 -

Source: Compiled by the authors using LATA, 2012

 There have been some bright spots in the industry as bankruptcy protection
has enabled several carriers to restructure their costs and receive wage
concessions from labor groups. Moreover, the overcapacity issue has been
addressed with carriers not only reducing capacity as a whole, but also shifting
capacity to international markets that are less competitive. Several LCCs have
also remained successful and profitable by continuing to expand while keeping
costs relatively constant. Innovations such as e-ticketing and fleet
rationalization have been instrumental in helping airlines achieve cost
reductions, and these reductions narrowed the cost gap between network
airlines and LCCs. Figure 1.2 provides a comparison between the network
carriers and LCCs in terms of Cost per Available Seat Mile (CASM).
18 8

Bailecacy CoiLcc — DIFF 7

16 +

Difference in CASM (S cents)

| al
f
Total CASM (5 cents)
ha
be

ae
al
ao oe

| 2

ra
ow

; : : x ' ‘ : . : = =
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Figure 1.2 Cost Comparisons between Low-Cost and Legacy Carriers

Source: Compiled by the authors using Form 41

Among network carriers, the most profitable airline was JAL. This
highlights a trend in the global airline industry where the cargo industry is
thriving because of the increased globalization of the business marketplace. In
terms of operating profit, network carriers did well especially in Europe and
Asia Pacific as shown in Table 1.8. Also, LCCs, all from different continents,
ranked among the highest commercial airlines based on operating profit margin
(Table 1.9), and net profit margin (Table 1.10).
The global airline industry is well on the road to recovery with the
International Air Transport Association (IATA) forecasting a global net profit
in 2012 of $3 billion. This global profit is largely spurred by a forecast that
Asia-Pacific carriers are expected to post large profits along with North
American carriers. European carriers are expected to make net losses as
Europe’s sovereign debt crisis remains a threat to earnings. Other dangers to
profitability are ever present, with fuel costs constituting the largest threat. In
fact, for many airlines, fuel costs are now larger than labor costs, and airlines
have few options in dealing with fuel costs. Moreover, since higher fuel costs
affect all airlines in a somewhat similar manner, there is little or no
competitive advantage to be gained in this area. Therefore, as this extra cost is
passed on to the consumer, the relative price structure should remain
proportionately the same. In this case, the ultimate question of profitability
depends to a large extent on the elasticity of demand for the product and the
cost containment ability of the airline’s management.
Table 1.8 Top 25 Airlines by Operating Profitability (2009 and 2010)

2009 2010

USD USD
Rank | Airline million Rank | Airline million

1 Emirates Airline O71 1 JAL Group 2,274

Fs Air China 834 2 Delta Air Limes 2217

3 FedEx Express 794 3 United Continental Holdings 1,818

4 Cathay Pacific 576 4 Air China 1,658

5 Ryanair Say 5 Lufthansa Group 1,642

6 Turkish Airlines (THY) 470 6 Emirates Airline 1482

7 LAN 436 7 Cathay Pacific 1,420

5 Lufthansa ¢ OUP TRH s FedEx Express 1,127

9 TAM 316 9 SLA Group L007

10 JetBlue Airways 285 10 Korean Air 989

iW Aeroflot Group 278 WW Southwest Airlines 988

1? China Eastern Airlines 276 12 United O76

13 Republic Airways 271 13 China Southern Airlines O54

14 Alaska Air Group 267 14 China Eastern Airlines S64

 15 AirAsia Berhad 263 15 ANA Group 18

16 Southwest Airlines 262 16 US Airways Group 781

17 UPS Airlines 259 17 Thai Airways Int'l. 757

18 South African Airways 258 18 Ryanair 689

19 GOL Linhas Aereas 248 19 Continental Airlines 660

20. | Copa Holdings 240 | 20 | LAN 623

21 China Southern Airlines 218 Z1 TAM 609

22 Sky West Inc. 212 22 Asiana Airlines 541

23 WestJet 211 23 British Airways 529

24 AirTran Airways 77 24 China Airlines 508

25 Qantas Group 174 25 | Aeroflot Group 499

Source: ATW World Airline Report

Table 1.9 Top 25 Airlines by Operating Profit Margin (2009 and 2010)

2009 2010

Rank Airline Percent Rank | Airline Percent

1 Mahan Air 35.6% 1 Mahan Air 35.25%

2 AirAsia Berhad 25.5% 2 AirAsia Berhad 33.9%

3 Allegiant Air 21.9% 3 Midew Airlines 29.9%

4 Middle East Airlines 21.4% 4 Shuttle America 26.2%

5 Abu Dhabi Aviation 20.7% 5 Abu Dhabi Aviation 25.1%

6 SA Express 19.8% & Astar Air Cargo 24.7%

Copa Holdings 19.1% 7 Cebu Pacifie Air 22.2%

8 Vensecar Int'l. 17.7% 8 Copa Holdings 20.5%

9 Holdings 16.5% 9 Lynden Air Cargo 20.2%

10 Spirit Airlines 15.9% 10 Alpine Air Express 19.8%

1 Royal Jordanian 15.7% WW Skymark Airlines 19.3%

12 Pullmantur Air 15.2% 12 Sabah Air Aviation 19.0%

13 Atlas Air W.W. Holdings 14.1% 13 Deraya Air Taxi 19.0%

4 Air Arabia 14.0% i4 Ryan Int'l Airlines 18.3%

 Cebu Pacific Air 13.6% Atlas Air W.W. Holdings 17.0%

Ryanair 13.5°% Vensecar Int'L. 16.7%

57 Airlines 13.2% Allegiant Air 15.8%

18 Alpine Air Express 12.5% Thai AirAsia 15.6%

19 North American Airlines 12.4% 19 Thomas Cook Belgium

20 Mongolian Airlines 12.3% 20 Gulf & Caribbean Air

21 REX —Regional Express 12.3% 21 USA Jet Airlines

22 LAN 11.9% 22 Middle East Airlines

23 Vueling Airlines 11.9% 23 Amsterdam Airlines 14.3%

24 Amsterdam Airlines 11.8% 24 Golet 14.2%

25 LAM Mozambique 11.2% 25 JAL Group 13.8%

Source: ATW World Airline Report: World Airline Financial Results 2010

Table 1.10 Top 25 Airlines by Net Profit Margin (2009 and 2010)
 2009 2010
Rank | Airline Percent Rank Airline Percent
1 Air Arabia 22.9% 1 AirAsia Berhad 314%

2 Skymark Airlines 19.9% 2 Cebu Pacifie Air 23.8%

3 Copa Holdings 19.8% 3 Thai AirAsia 23.0%

4 Middle East Airlines 19.4% 4 IndiGo Airlines 20.6%

5 Vensecar Int'l. 17.1% 5 Lynden Air Cargo 19.1%
6 AirAsia Berhad 15.9%, 6 Ryan Int'l Airlines 18.3%

7 GOL Linhas Aereas 1.8, 7 Indonesia AirAsia 17.2"

8 Cebu Pacific Air 14.0% 5 Copa Holdings 17.0"

9 Allegiant Air 13.7% 9 Cathay Pacific 15.9

10 | TAM 12.8% 10 Nok Air 15.6%

1] SA Express 12.3% 11 Thomas Cook Belgium 15.5%

12 AirAsia X 12.1% 12 SA Express 15.0%

13 Spirit Airlines 12.0% 13 Air China 15.0%

14 Nok Air 11.6% 14 Air Arabia 14.9%

15 | Ethiopian Airlines 11.0% 15 Xiamen Airlines 14.5%
16 Ryanair 10.2% 16 Sabah Air Aviation 14.3%
7 REX —Regional Express 10.0% 17 Astar Air Cargo 14k

18 Hawaiian Holdings 9.9% 18 Hainan Airlines 13.9"

19 Abu Dhabi Aviation 9.6% 19 Abu Dhabi Aviation 13.9%

20) «| Air China 9.3% 20 Juneyao Airlines 13.9%

21 | Tyrolean Airways 9.1% 21 Middle East Airlines 13.4%
22 Air Astana 8.6% 22 Onini Air Int’. 13.3%

23 Nouvelair Tunisie 8.4% 23 Kalitta Air 13.3%

24 Emirates Airline 8.1% 24 Everts Air Cargo 12.4

25 | Turkish Airlines (THY) 7.9% 25 Centurion Air Cargo 12.3%

Source: ATW World Airline Report: World Airline Financial Results 2011

CONSOLIDATION AND BANKRUPTCIES

The airline industry has been affected by economic recession, rising fuel costs,
political uncertainty, and stiff competition. These factors have caused many
major carriers, such as Eastern Airlines, Pan American, and Piedmont into
liquidation and American Airlines, US Airways, United Airlines, Delta Air
Lines, and Northwest Airlines into bankruptcy protection. The period
immediately following deregulation (1980s) saw one of the most turbulent
periods for commercial aviation in the US and the greatest rate of airline
bankruptcies. Since 1990, more than 189 airline bankruptcy filings have
occurred. In more recent times, Delta and Northwest filed in 2005 and later
merged, shortly followed by United and Continental in 2010.

“Tf you look at the history of mergers, the assumption was that you couldn’t do them successfully.
Everybody had come to the conclusion that these things are too big, too complex and too unwieldy to
manage.”
Richard Anderson, Delta’s Chief Executive

Table 1.11 displays the market share for various US carriers for the
domestic market. In 2000, Southwest Airlines passed Delta Air Lines to
become the largest domestic carrier (in terms of passengers flown) in the US,
and it has maintained its ranking through 2011. This highlights the fact that
LCCs are capturing more of the domestic market share while legacy network
carriers are losing theirs. This is mainly due to the LCCs’ continual expansion
and the advantages they possess because of their lower cost structure. Another
major trend (in terms of market share) is the emergence of regional carriers. In
1998 Expressjet, American Eagle, and Skywest had less than 1 percent
combined market share, yet in early 2006 they had acquired 7.5 percent of the
total US domestic market. In this case, the reason was the increased use of
regional jets by legacy carriers to open up new markets and to combat LCCs.

Table 1.11 US Airline Industry Domestic Market Share

 Airlines 2004 2005 2006 2007 2008 2009 2010 2011

Southwest Airlines 16.9%. 17.5% 18.8% 19.8%. 20.7" 21.5% 215% 21.6%

American Airlines 11.3% 11.5% 11.2% 110%. 10.9% 10.1% 98%, 9.55%

Delta Air Lines 12.5%. 11.5% 9.0% 8.1% Sie BAe 12.6% 12.9%

United Airlines 9.7% 8.7% 8.3% £.1% Fate 7% 6.4% 5.9%

US. Airways 6.9% 6.5% 5.3% 5.6% 75% 72% foto 6.9%.

Northwest Airlines 7.d 7 ty 7% 6.9% 5.6 "hs 5.1% 0.0% 0.0%

Continental Airlines 5.15 5.1% 5.5. 63% 5.8% 5.84) 17 4,7

JetBlue 2.6% SAY Fes 3.6 To 4.0% 4h $A 1.6% 4.9%

AirTran Airways 24% 27% 33% 4.0% 44% 45% 4.5% 4.4%

Alaska Airlines 2.6% 2.6%) 25% 2.4% 25% 25% 2.5% 27%

American Eagle 2.2 to 2.5% 27m 2.6% 2.4% 2.3% 2.4% 2.4%

Skywest Airlines 0.0% 0.6% 2.6% 2.7% 2.8% 3.0% 3.3% 3.2%

Atlantic Southeast Airline 1.5% 1.7% 15% 1.5% 1.6% 1.7" 1.8% 1.9%

Frontier Airlines 1.2% 1.20 1.5% 1.6% 1.6% L.'% L.6%% 1.8%,

Industry Herfindahl Index $52.0 833.1 807.5 836.8 $69.8 B73.2 930.3 926.5
Source: Compiled by authors using OAG Data

Historically, mergers rapidly increased following deregulation in 1978,

and for the ten years following deregulation, there were 51 airline mergers and
acquisitions (Dempsey, 1990). The result of these mergers and acquisitions
was the creation of six legacy carriers from the 15 independent carriers that
had close to 80 percent US market share in 1987 (Dempsey, 1990).
While the number of mergers reduced during the 1990s, critics argue that
most mergers still were part of well-planned strategies to lessen competition
in various markets. As a result, starting in 1985 the Department of
Transportation (DOT) assumed approval authority for all airline mergers. To
approve the merger, the DOT must now balance the consumer benefits resulting
from mergers against the possibly negative effects of increasing concentration
(Dempsey, 1990). On the other hand, the extraordinary financial problems of
legacy carriers suggest that reductions in capacity, whether through mergers or
alliances, may be inevitable. Some economists argue that less intense
competition, through consolidation and coordination, can actually benefit
consumers by allowing airlines to build more efficient networks with greater
economies of scale, scope, and density. Figure 1.3 provides a framework of
the major airline mergers that have occurred in the US since deregulation.
 The industry Herfindahl-Hirschman index (HHI) is a measure of US market
consolidation. As Table 1.11 shows, since 1998 the industry has become less
consolidated.” This spreading out of competition usually equates to lower fares
and increased service. In fact, an American Express travel survey has shown
that average US domestic airfares have steadily declined since 2000 (Amex,
2006). While mergers and acquisitions have slowed in the US, the relatively
low HHI and the poor financial condition of the legacy carriers indicate that
there is still the potential for additional mergers and acquisitions within the
industry. Moreover, airline mergers are not limited to the US and have played a
large part in international aviation. A few recent international mergers include:

¢ Air France and KLM

¢ Cathay Pacific Airways acquired full ownership over Dragonair
¢ Cimber Air acquired bankrupt Sterling
¢ Lufthansa and Swiss Air
¢ Air Canada acquiring Canadian
¢ Japan Airlines purchase of Japan Air System
¢ British Airways and Iberia.

Historically, mergers have not been overly successful in the aviation industry.
Many mergers do not obtain the envisioned benefits, and one-time merger costs
such as aircraft painting and IT harmonization end up being far more costly
than planned. Airline mergers also have difficulty in dealing with labor groups,
especially with regard to issues such as merging seniority lists. Corporate
culture can also be a much underestimated barrier to successful mergers as
different companies’ cultures may impede merger success. Finally, one of the
greatest challenges a merger faces is managing multiple and powerful
stakeholders; these can include but are not limited to politicians, regulators,
labor leaders, and consumers (McKinsey & Company, 2001). Many of these
stakeholders are suspicious of the mergers because they fear lessened
competition and increased travel prices (McKinsey & Company, 2001). Many
potential mergers have been thwarted by regulators, and one of the key
measures regulators use in analyzing potential mergers is the planned mergers’
effect on the HHI.
 American .
~ Amencan
00) i

Trans World
Trans World
‘Ovark

Northwest

North Central Northwest

> Republic
Southem > Republic
Hughes Arrwest

Delta
> Delta
Northvest
Westem
Pan Ameri ithentic and Shuttle
mm Division

National Pocific Division

United Unite!

United

Contineatal Continental
Pioneer
F ; Texas International Texas Air Group Continental
Trans Texas.

New York Air

Monarch
Frontier
Challenger
Anzona
People Express
Pietea im—* Bases

Eastern Metro
Florida—
Eastem Shuttle Ti

Allegheny

Pacific Southwest

Pigdmont
America West

Southwest

Monna Air

Air tran

Figure 1.3 Evolution of US Airline Industry

 However, there are, as mentioned, potential benefits from airline mergers.
McKinsey & Company estimate that a merger of two mid-sized carriers could
unlock synergies in excess of 7 percent (McKinsey & Company, 2001). The
major benefit of mergers is cost rationalization. Since the airline industry
exhibits large economies of scale, merged airlines are able to spread their high
fixed costs over a greater network. Additionally, the new merged carrier can
increase its bargaining power with key suppliers and merge such functions as
parts inventories, back office functions, and sales forces (McKinsey &
Company, 2001).
Another major benefit of mergers is network harmonization. Network
harmonization can include a variety of things, and using the last analysis as an
example, the merged airline’s route network is greater than that of the
individual airlines. A good example of this is the America West/US Airways
merger. America West was predominantly a west-coast airline while US
Airways was primarily an east-coast airline, but the merged airline had a
strong route network on both coasts. Without a merger, both carriers would
have had a difficult time increasing their presence on the opposite coast. The
economies of scope that resulted from the merger allowed US Airways to
widen its customer base and strengthen its market power throughout the US.
Another way to look at consolidation in the domestic US industry is to look
at it from the airport level. After deregulation, the major carriers adopted a
hub-and-spoke system which funneled passengers through a few airports
(Dempsey, 1990). This in turn led to some carriers holding dominant positions
at certain hub airports throughout the US. Table 1.12 depicts the consolidation
of carriers by enplanements and operating carrier at the ten largest airports in
the US:
The general trend in airport consolidation from 2004 through 2011 is one
where the largest carrier has become less dominant. This has occurred for all
the airports presented in Table 1.12, except for Dallas and Las Vegas. In
Dallas, Delta’s withdrawal left American Airlines as the only major airline
still operating, while simultaneously leaving Dallas as the most consolidated
airport of the top ten domestic US airports between 2004 and 2011.
The general reduction in consolidation at US airports can largely be
attributed to two factors: 1) increased competition, particularly from LCCs;
and 2) major carriers pushing more flying to regional affiliates. LCCs such as
Frontier and AirTran have situated themselves in the dominant hubs of Denver
and Atlanta, and have been successful at taking away market share in those
airports. With the emergence of regional jets, major carriers have been pushing
capacity toward regional carriers in an effort to reduce costs. As an indication
of this trend, in May of 2007, Bombardier Aerospace introduced the next
generation versions of its CRJ700, CRJ900, and CRJ1000 regional jets. These
new CRJ NextGen aircraft have featured significant operating cost
improvements and the increased use of composite materials.
Since the Form41 data used in Table 1.12 breaks data down by operating
carriers, regional carriers are treated separately. For example, ExpressJet
operations at Houston are separate, even though the flights are marketed by
Continental. This could potentially distort the level of consolidation at airports
with large regional carrier presence.
As shown in Table 1.12, the HHI indicates a decline in consolidation for
the US domestic airline industry when consolidation is analyzed on an airport
basis. However, it is important to remember that the level of consolidation at
major US airports is much greater than the level of consolidation of the airline
industry. The least consolidated US airport in the list, Los Angeles, still has a
HHI score well above the airline industry’s level of consolidation. Therefore,
in at least a few markets, potential airline mergers could have a much greater
and controversial effect on the level of consolidation at some major airports.

Table 1.12 Major US Airports Concentration (with Enplanements by Operating Carrier)

2004 2005 200 2007 2008 200 2010 2011

Largest Carer BRAS 66.8%) «0 o% 56%, 56.7% a ed 61.1% 65.6%

Atlanta (ATL) Largest Carrer 1 DT DL 1 DI DIL D1 DL

Herfindahl Index 4916 4754 4063 afl 37 bt a70F 416 4682

Largest Carrier % APs 36.5% 36.4% 36.2% 36 34.2% 31,0% 28,5

Chicago (ORD) Largest Carrier UA LA LA BA UA UA LA UA

Herfindah! Index 2716 2421 Zane 23309 2320 2091 1847 1686
Largest Carrier %s 65.8% 7a.8% FAB Fa. 74.6% 74.6% 74d Tae

Dallas (DFW) Largest Carrier ALA, ALA AA AA, ACA AA ALA, AA

Herfindatl Index 4521 5a? 5612 S665: 570 5708 S68 5566
Largest Carrer") 48.8% 4 4 41.6% S80) 42 Sy 26.1% 24.7%

Denver (DEN) Largest Carrier LA LA UA UA, DA UA UA UA

Herfindahl Index fen 2432 2468 2340 2140 1838 1673 1596
Largest Carrier ™ 674% 64.6% G3P% 624% SRA SEI 51S 475%
Detroit (OT WW) Largest Carrier NW NW Bey Le NW AVY Dl DI

Herfindah! Index bb Ral as58 4220) 1086 So40 ae 257 25Se

 Largest Carrer 66.7 6% 63.7 65.1% 65.6% 65, 1%. 41h OAs:

Houston (LAH) Largest Carrier CO Co Co co Co co CO CO

Herfindahl Index 4855 4711 4715 4653 4695 4712 4655 4469

Largest Carrier % 33.0% 33.79 36.5% 371% 38.8% AL. SS 413.0% 42.1%

Las Vegas (LAS) Largest Carrier WN WEN Why WN Wi Win WN Wh

Herfindahl tndex 1705 1701 1835 1753 | 982 2097 2199 2110

Largest Carrier "\ 21.9% 20.5% 211% 19.4% 1a 3 17.6% V7. Sy 15,7

Los Angeles (LAX) Largest Carrier UA UA UA UA UA UA UA LA

Herfindahl Index 1268 1200) 1303 124 1191 1180 1236 1148

Largest Carer% aos 61h 67 4% iF 2 G2 SS me oh

Minneapolis (MSP) Largest Carrier AYA BA NW A AW AY DL DI

Herfindahl Index 4930 4625 4663 632 3997 170 Ss 2B44

Largest Cartier %) 38.1% 37.5% 35.5% 304% 29.6% 29.9% 30.5%. 315%
Phoenix (PHX} Largest Carrier HP Hr HP WN Wh WN Wh WI

Herfindahl Index 2387 2411 2360 1893 2555 2604 2716 2759

Source: Compiled by authors using Form4l Data

FACTORS AFFECTING WORLD AIR TRAFFIC GROWTH

The factors that affect world air traffic growth are numerous, complex and
occur on global, national, regional, and civic levels. This complexity helps
explain why air travel can grow significantly in one country or city and why it
can stagnate or flounder in another; chief among these factors is the level of
prosperity in the region. This amount of economic prosperity is measured by
such indicators as Gross Domestic Product (GDP) or Gross National Product
(GNP). GDP is the total market value of all final goods and services produced
in a country in a given year. Increased prosperity derives increased demand for
air travel in two separate but concurrent ways. First, increased economic
activity helps generate employment, which ultimately causes an increase in
business travel, the most important segment of travelers for airlines. Business
travel is the primary reason why world financial centers such as London and
New York have experienced strong air traffic growth. Additionally, increased
economic activity will also spur air cargo growth.
The second result of economic prosperity is a decrease in unemployment
and a concurrent increase in household income. People have more
discretionary income and are more able to afford more leisure travel trips. A
good example of this has been in China, where a growing middle class has
fueled a large expansion of air travel within the country.
 A decrease in the real cost of air travel will also create air traffic growth.
This was first experienced in the 1970s when deregulation resulted ina
dramatic decline in the cost of air travel. Air travel was now affordable to a
greater number of people and they took advantage of the opportunities. LCCs
generated increased air travel with low fares, and airports experienced
tremendous growth in their passenger statistics once a low-cost airline
initiated service. This phenomena has been coined the “Southwest Effect.”
Ryanair is accomplishing similar feats in Europe where weekend getaways are
now affordable to almost everyone.
Another factor influencing world air traffic growth is population growth
rates. Strong population growth rates in developing countries such as India and
China have helped spur air travel growth. However, population growth must
generally be accompanied by income growth for this factor to significantly
affect air travel.
Economic liberalization is another major factor impacting air
transportation. Government restrictions on an economy, such as wage and price
controls or excessive regulation, ultimately constrain demand. When such
artificial barriers are lifted, the marketplace dictates demand for goods and
services and increased air travel is almost always the result. The reason for
this is the fact that government regulation in the aviation industry usually
involves ticket prices and market access. That is, favored airlines (usually a
national airline) are granted monopoly access with some sort of a fare
structure that is structured to cover average costs. This effectively eliminates
competition and restricts the growth of air traffic. A good example of economic
liberalization is the US itself: Following deregulation, airfares plummeted and
air traffic growth increased significantly. Moreover, the freedom for airlines to
fly to whatever destination they wished made flying more convenient for
passengers by providing more non-stop flights with greater frequency. Recent
air transport liberalization in Europe and India has led to a tremendous growth
in air traffic in these countries.
Politics and political stability also play a role in air travel. It is not
surprising that countries that choose extremely protectionist and radical
policies do not experience great air traffic growth; in these cases the
government restricts air travel as a matter of political policy. Political
instability can also greatly influence air travel, since people do not want to
travel to regions where they feel unsafe. It is likely that political instability can
be blamed for the poor air traffic growth rates in those parts of Africa where
governments are in constant turmoil. Finally, political instability reduces
and/or restricts business activities within the country.
Terrorist attacks can also affect air travel. Following the tragic events of
September 11, air travel dropped off drastically as passengers no longer felt
safe traveling. Additionally, many felt unsafe to travel to international
destinations in the event that some other terrorist attack would occur. Finally,
the amount of leisure time people have can impact the demand for leisure
flights. Typically, individuals who possess greater discretionary free time have
a greater demand for leisure and/or vacation flights. Tourism promotion can
also help spur an increased demand for air travel to a particular destination.
For example, Walt Disney World has turned Orlando into the number one
destination airport in the US.

ECONOMIC IMPACT OF THE AIR TRANSPORT

INDUSTRY
Commercial aviation is comprised of two primary segments: large commercial
air carriers and regional/commuter air carriers. Since deregulation of the
commercial airline industry in 1978, both the large commercial and
regional/commuter air carriers have enjoyed more robust growth than the
domestic economy. Generally, the commercial airline industry has closely
followed the movement of the domestic economy. After deregulation, the large
US commercial air carriers have averaged an annual revenue growth of 4.8
percent, compared to a 2.6 percent average growth rate of the US gross
domestic product. During this same time period, US regional/commuter air
carriers grew at an annual growth rate of 14.3 percent.
More recently, the Federal Aviation Administration (FAA) forecasts long-
term growth in enplanements for large US carriers to average 2.7 percent
domestically and 4.2 percent internationally through 2030, while growth will
average 2.9 percent for regional/commuter airlines. And, as has been
mentioned, international aviation continues to grow with IATA forecasting
higher growth rates than the US industry (Pearce, 2006). This growth has been
largely spurred by the soaring economies in the Asia-Pacific region. The
following section explores the economic impact that the growth of air
transportation is likely to have on the economy.
Economic impact can be divided into three categories: direct, indirect, and
induced. Direct impact represents economic activities that would not have
occurred in the absence of air transportation. In the air transportation industry,
both airlines and airports provide the economy and local communities with a
direct economic impact. Examples of direct economic impacts include the
salaries of airline personnel, fuel purchased, landing fees, salaries of airport
personnel, and other similar purchases and expenditures. Indirect economic
benefits include the financial benefits that are attributed to airport/airline
activities. Examples of indirect economic impacts for air transportation
include hotels, restaurants, and other retail activities. There is usually a causal
relationship between the industry and indirect impacts. For example, if there
were a reduction in air travel for a community, the hotel industry in that
community would most likely realize a fall in occupancy rates as well. Finally,
induced economic impacts are the multiplier effects of the direct and indirect
impacts. Induced impacts account for the increased employment and salaries
that come from secondary spending that is a result of the direct and indirect
economic impacts. The total of these economic impacts measure the
importance of an industry in terms of the employment it provides and the goods
and services it consumes. The following sections explore the effect of air
transportation on each of these economic impacts.

Direct impact

Direct economic impacts are the consequences of what might be termed first-
tier economic activities carried out by an industry in the local area. In the air
transportation industry, airports provide the greatest direct impact to local
economies. The reason for this is the more or less obvious fact that the
economic activities that take place at the airport directly involve the local
economy. Most direct impacts, like airport employment and fixed-based
operations, occur at the airport; others, like local production of goods and
services for use at the airport, may occur off site. In 2011, Over 56 million
people are employed worldwide in aviation and related tourism. By 2026, it is
forecast that aviation will contribute $1 trillion to world GDP.
Expenditures by airlines, fixed-based operators, and tenants also generate
direct impacts, but only those expenditures that lead to local business activity
are relevant for a regional economic assessment. For this reason, it is
important to distinguish between the local value-added component of
expenditures and the regional import component. Thus, airline expenditures on
fuel generate local fuel storage with distribution systems and they also
contribute to the importation of fuel into the region. In most parts of the country,
only the former component is relevant for any local economic impact analysis.
Therefore, the direct economic impacts of air transportation for a community
are usually measured based on the airport’s immediate economic activity.
Additionally, large aircraft manufacturers can have a huge direct economic
benefit by locating their production facilities in a given community or state.
For example, the direct economic impact of the Boeing 787 Dreamliner project
on the state of Washington in 2006 has been estimated at approximately 11,470
jobs with an economic output of $2.268 billion (Deloitte, 2004). There are of
course numerous other examples of large direct economic impacts that are
provided by the air transportation industry. If aviation were a country, it would
rank 19th in the world in terms of GDP by generating about $540 billion worth
of product and services per year.*

Indirect impact

Indirect impacts derive from off-site economic activities that are attributable
to air transportation activities. For example, indirect economic impacts include
services provided by travel agencies, hotels, rental car companies, restaurants,
and retail establishments. These enterprises have a strong relationship to the
air transportation industry and, like airport businesses, employ labor, purchase
locally produced goods and services, and invest in capital projects. Indirect
impacts differ from direct impacts because they originate entirely off-site.
Typically, indirect economic impacts are generated by visitors to the area who
are traveling by air. A good example of an industry that has a strong indirect
economic impact relationship with air transportation is the hotel industry.
Airlines provide economic benefits to the hotel industry by requiring hotel
rooms for passengers who have business in, or are vacationing in a city. This
increased demand for hotel accommodation in the city creates employment and
may require construction of more hotels, thereby creating more economic
impact. The large demand for hotel accommodation caused by air
transportation is one of the main reasons why areas around major airports
almost always contain many hotels.

Induced impact
As mentioned earlier, induced economic impacts are the multiplier effects that
are caused by the increases in employment and income generated from the
direct and indirect economic impacts of air transportation. A simple example
will help make this concept clear. Imagine a new airline employee who
purchases a house in the local community. The builder of the house then uses
this income to purchase other goods and services and the income to the
suppliers of these goods and services is also spent. This framework of
expenditures is the basis behind the multiplier effect; that is, one transaction
leads to multiple economic transactions.
More economically self-sufficient regions tend to have higher multipliers
than do regions that are more dependent on regional imports, since more of the
spending and re-spending is done within the region. Therefore, the larger the
region under consideration, the higher the multiplier will be.

Total impact

Total economic impact is defined as the sum of direct, indirect, and induced
impacts. Total impact is usually expressed in terms of economic output,
earnings, or employment (sometimes full-time equivalents). The basic formula
for total economic impact is:

Total Impact = Direct Impacts + Indirect Impacts + Induced Impacts

Table 1.13 provides a comparison of the total economic impact in terms of

employment for 11 airports located in the US. The report for each airport was
done independently and at different times, but the methodology used for each is
similar. While the 11 airports vary in size, they all provide strong economic
impacts for their communities. When normalized in terms of commercial
departures, Memphis generates one job for every departure, or in other words,
one additional daily flight would generate approximately 365 new jobs for the
region. Wichita’s extremely high ratio of three is probably attributable to the
large manufacturing and maintenance facilities for Cessna and Bombardier.
The presence of Federal Express in Memphis explains its high economic
impact to departure ratio. And finally, much of Seattle’s total economic impact
can be attributed to the simultaneous indirect economic impact of the presence
of aircraft manufacturing giant Boeing and of tourism.
Table 1.13 The Economic Impact of Selected Airports

Airport Year of Report Total Jobs Total Jobs per Commercial Departure
Cincinnati/Northern Kentucky 2000 78,373 0.651

Wichita 2002 41,634 3.184

Seattle-Tacoma 2003 160,174 0.964

Greenville-Spartanburg 2003 5,787 0.246

Memphis 204 165,901 1.010

Minneapolis-St Paul 2004 153,476 0.630

IF Green Rhode Island 2006 21,857 0.781

Portland International 2007 38,571 0.429

Central Wisconsin Airport 20M? 981 0.075

Southwest Florida International 2010 41,588 0.979

Anchorage Internati: onal 2U11 15,500 0,115

Source: See chapter references for all source documents

These disparate examples highlight the diversity (cargo operations,

manufacturing, and tourism) and strength of the economic impact of the aviation
industry.

OUTLOOK FOR THE AIR TRANSPORT INDUSTRY

Over 1,700 airlines operate a fleet of 23,000 aircraft by serving 3,750 airports
around the world.” Since demand for the air transport industry is highly
correlated with overall economic growth, it is not surprising that the global
outlook for the air transport industry mirrors the global economic outlook. The
airline industry was hit hard in 2011, by the persistent financial problems, and
global financial problems after a strong rebound in 2010.° Therefore, the air
transport industry is expected to grow significantly in regions where
economies are developing, such as Asia-Pacific, while other regions’ air
transport outlook is expected to be steady. GDP and economic growth are
strong leading indicators of the air transport industry’s growth, so in the short-
term these measures can be used to assess the industry.
However, direct correlations between GDP and air transport growth are
never exact due to a variety of issues. For example, structural barriers in the
air transport industry can cause drastic differences between economic growth
and the growth of the air transport industry. A good example of this was the
effect of deregulation in the US; deregulation was a major structural change
that caused a rapid increase in the air transport industry’s growth compared to
overall economic growth.
Airport capacity and, in the US, antiquated air traffic control, are also
potential structural barriers. Major international airports in the US and Europe
have severe capacity issues with relation to the number of aircraft that they are
capable of handling. As these capacity limits are reached, delay at these
airports tends to increase in an exponential fashion. These delays, especially if
they are on an ongoing basis, discourage demand and constrain growth.’
Similar capacity issues could plague airports in the Asia-Pacific region,
especially Indian, Chinese, and Japanese airports. This capacity barrier to air
transport growth is a prime reason why Airbus embarked on the creation of its
new super-jumbo A380 aircraft.
The two major sources for the long-term air transport outlook are Boeing
and Airbus. Each aerospace giant has published forecasts for the future of the
aviation industry. They have similar growth estimates for world air traffic
growth with Boeing forecasting that world revenue passenger kilometres
(RPK) will grow at 5.0 percent per annum for the next 20 years. Table 1.14
summarizes the average regional growth rate forecasts between Boeing and
Airbus.
Both Airbus and Boeing also forecast worldwide demand for new aircraft
for the next 20 years. Not surprisingly, each company’s forecasts vary slightly,
highlighting each company’s strategic plan and product offerings. Boeing
estimates that there will be demand for 33,500 aircraft seating over 90
passengers in the next 20 years, while Airbus forecasts a worldwide demand
for 26,900 similar-sized aircraft over the same period. While both companies
agree that roughly 70 percent of the demand for new aircraft will be for single-
aisle aircraft, Airbus predicts a greater demand for large wide-body aircraft,
while Boeing believes the remainder of aircraft demand will be for small and
medium wide-body aircraft. Airbus forecasts demand for 1,331 very large
aircraft (747s and A380s) while Boeing only forecasts 820 aircraft in this
segment. Additionally, the firms differ on where demand for new aircraft will
be. Boeing still forecasts that North America will be the largest market for
new aircraft (mostly narrow-body aircraft); while Airbus forecasts the Asian-
Pacific market will order the most aircraft in the next 20 years. Additionally,
Airbus foresees greater LCC growth in this region to spur narrow body sales.
Table 1.14 Regional Economic Growth Forecast

2011-2030 Estimated Growth

Region GDP RPK

North America 2.7 Me 3.2%

Latin America 4.2% 6.9%

Europe 2.0% 4.3%

CTs a4% 5.0%

Middle East 41% 8.2%

Asia 4.7% 6.7%

Africa ba 5%

World 3.3% 5.0%

Source: Compiled by authors using Airbus Global Market Forecast 2011-2030 and Boeing Current Market Outlook 2011-2030

One other sector of the air transport industry that should be mentioned is
the air cargo market. Both Boeing and Airbus forecast world air cargo to grow
by about 6 percent per year for the next 20 years. This worldwide forecast
growth outstrips passenger growth forecasts, and this situation is especially
true in international markets where the air cargo industry has not developed to
the extent of the passenger industry. As a result, demand for cargo aircraft (new
or second-hand) is expected to be strong, especially for wide-body aircraft.
China is expected to lead the way in air cargo growth, both domestically and
internationally. The US domestic air cargo market appears to be mature with
Airbus forecasting a modest 2.8 percent annual air cargo growth and Boeing
forecasting a 4.8 percent growth rate

SUMMARY
With relatively minimal profits margins, the financial condition of the aviation
industry is highly dependent on the global economic conditions of the day.
During times of economic boom, profits soar and in times of distress carriers
are forced to cut back capacity. This chapter introduces the reader to the
present state of the aviation industry with a representative data set that covers
the volume of traffic, the existing finances, mergers, bankruptcies, and levels of
concentration within the industry. The chapter then covers the economic impact
of the industry along with forecasts for future growth. The purpose of this
chapter is to describe the evolution of the air transport industry including
airlines and airports. As the preceding discussion and statistics amply
demonstrate, the chapter introduces the industry as a large and growing
segment of the domestic and international economies. As such it is an important
area for economic analysis. Although the industry is similar in some ways to
other large industries, it has some peculiar characteristics that can best be
understood in the context of standard economic analysis. This text aims to
apply economic analysis to the industry to explain and illuminate those
characteristics. To that end the first four chapters of the text will introduce the
reader to basic economic theory including demand, supply, costs, and
production analysis. These ideas will be presented in the context of the
aviation industry and will be presented with applicable examples from the
industry.

DISCUSSION QUESTIONS
1. What are the factors influencing world air traffic growth?
2. The Airline Deregulation Act of 1978 practically removed government
control over fares, routes and market entry from commercial aviation.
a Identify some of the characteristics of the US airline industry before
deregulation.
b How did this era affect airlines and passengers?
c Was deregulation successful?
3. What are direct and indirect economic impacts related to air transportation
and how do they differ? Provide an example of each.
4. Which regions serve the largest number of passengers? Movements? Cargo?
5. Does regional aviation activity reflect in average age of aircraft by region?
6. What are the top five busiest airports in terms of passengers? International
Passengers? Cargo?
7. What are some trends with respect to consolidation in the industry? At
airports? How is this demonstrated in the HHI?
8. Mergers have been an important part of the airline industry. Have they been
successful?
9. Which regions are forecasted to have the highest growth in aviation over the
next 20 years?

REFERENCES
Amex. (2006). 2005 US Domestic Airfares for American Express Business Travel Clients Drop to
Six-Year Low. Retrieved on August 31, 2006 from
http://home3.americanexpress.com/corp/pce/2006/4q05_monitor_print.asp.

Center for Economic Development and Business Research. (2003). Wichita Mid-Continent Airport
Economic Impact. Retrieved on September 13, 2006 from
http://webs. wichita.edu/cedbr/A irportImpact.pdf.

Deloitte. (2004). Employment and Income Analysis of the Boeing 7E7 Project. Retrieved on September
13, 2006 from http//www.aia-
aerospace.org/stats/resources/Boeing_EmploymenAndIncomeAnalysis.doc.

Dempsey, P. (1990). Flying Blind: The Failure of Airline Deregulation. Washington, DC: Economic
Policy Institute.

Economics Research Group. (1999). The Cincinnati/Northern Kentucky International Airport

Economic Impact Analysis. Retrieved on September 13, 2006 from www.cba.uc.edu/econed/1998-
201 1impact.pdf.

John C. Martin Associates. (2005). The Local and Regional Economic Impacts of the Minneapolis/St
Paul International Airport. Retrieved on September 13, 2006 from
www.mspairport.org/msp/docs/misc/mspimp04_ FINAL.pdf.

Martin Associates. (2005). The 2003 Economic Impacts of the Port of Seattle. Retrieved on September
13, 2006 from http//www.portseattle.org/downloads/business/POS2003EIS_Final.pdf.

McKinsey & Company. (2001). Making mergers work. Airline Business. Retrieved on August 31, 2006
from Air Transport Intelligence.

Pearce, B. (2006). New Financial Forecast. IATA Industry Financial Forecast, September. Retrieved on
August 31, 2006 from www. iata.org/economics.

Sparks Bureau of Business and Economic Research. (2005). The Economic Impact of Memphis
International Airport. Retrieved on September 13, 2006 from
www.memphisairport.org/EcImpactFinal. pdf.

Wilbur Smith Associates. (2003). The Economic Impact of Greenville-Spartanburg International

Airport — Update 2003. Retrieved on September 13, 2006 from
www. gspairport.com/images/downloads/A irlmpact.pdf.
1 Boeing Current Market Outlook 2011-2030.
2 For more information on HHI see Chapter 9.
3 Air Transport Action Group (ATAG), 2012.
4 Air Transport Action Group (ATAG), 2012.
5 Air Transport Action Group (ATAG), 2012.
6 Zacks Equity Research, January 10, 2012.
7 See Chapter 5 for an analytical discussion of this issue.
 2
Principles of Economics with Applications in
Aviation

Economics is haunted by more fallacies than any other study known to man. This is no accident.
The inherent difficulties of the subject would be great enough in any case, but they are multiplied a
thousand fold by a factor that is insignificant in, say, physics, mathematics, or medicine—the special
pleading of selfish interests.

Henry Hazlitt, American economist and journalist (1894-1993)

This chapter introduces students to the “economic way of thinking” primarily

through the study of incentives and prices. Economics is a social science and
similar to other social sciences, it has its own concepts, presumptions, and
rules. Throughout this chapter we will examine the basic concepts of scarcity,
choice, and opportunity cost in economics. The subject of economics is
generally divided into two major sections: microeconomics and
macroeconomics.
Microeconomics is a subdivision of economics that studies how individual
households and businesses make decisions to distribute limited productive
resources to maximize profit. Microeconomics focuses on pricing strategy and
production policy and how to assign the products and services among the
competing customers. Macroeconomics is the aggregate of microeconomics
and examines the economy as a whole, and deals with the subjects of
unemployment, inflation, and economic growth. We will look at these two
fields of economic thought through an in-depth analysis of the characteristics
and importance of each. The basic economic framework can then be applied to
issues in aviation including the role of government in aviation, deregulation,
operating costs, foreign operations, and certification. We then present
economics as a discipline for informing and critiquing political policy.

¢ Basic Economics
* Scope of Economics
— Microeconomics
» Pricing decisions
 » Output decisions
» Choice and opportunity cost
— Macroeconomics
» Inflation
» Unemployment
» Natural unemployment
» Cyclical unemployment
» Frictional unemployment
¢ The Role of Economic Systems
— Government and aviation
¢ Government Failures and Market Failures
e Summary
¢ Discussion Questions

BASIC ECONOMICS
Economics may be defined as the science of decision-making and resource
allocation under scarcity. Many decisions carried out throughout the aviation
industry are prime examples of economic decisions where scarce or limited
resources have to be allocated. An example of this was the decision to
construct a $1.28 billion fifth runway at Atlanta’s Hartsfield-Jackson airport
(ATL) to increase the operational capacity of the airport. Broadly speaking,
every resource is scarce, and the allocation of resources under a variety of
incentives and decision-making parameters forms the core of economic
analysis. An important feature of economic analysis is the assumption that
people understand and can act in their own best interest. That is, people
respond predictably to a given set of choices in order to maximize their
benefits or minimize their losses. Though this is sometimes referred to as the
fundamental assumption of economics, economists believe it is not an
assumption at all but a simple fact confirmed by common empirical reality. For
instance, individuals will engage ina search process to find the lowest ticket
price for a given itinerary and set of requirements like flexibility, refundability,
and service level. However, there is a limit to the amount of time they will
spend in such market research since the time spent searching for the best price
has a cost, as it is time that could be spent in doing something else.
 “The only way that has ever been discovered to have a lot of people cooperate together voluntarily is
through the free market. And that’s why it’s so essential to preserving individual freedom.”
Milton Friedman

This implicit cost of resources is known as opportunity cost, and is yet

another fundamental concept in economics. Opportunity cost is defined as the
alternative cost of using a resource; that is, the benefits that would accrue if the
resource were being utilized in its next best allocation. In other words, the next
best use of the resource is the economic cost of using it in the current
allocation. For instance, in the above example, the opportunity cost of the time
spent in searching for the best ticket price is the next best use of that time,
perhaps in running the company, generating greater sales, or spending time with
one’s family. For an airline, the opportunity costs of acquiring a new aircraft
could be an alternative use of that money, perhaps in acquiring another type of
aircraft, opening a new route, or restructuring.
The opportunity costs of a resource determine the eventual allocation of
those resources. To continue with the example above, as long as the
opportunity costs of time do not exceed the potential cost savings that can be
achieved, the individual will continue the search. When the opportunity cost of
time exceeds the potential cost savings, the individual will cease the search
and take the best price that can be found.
Continuing the example, travel aggregators like Expedia.com and
Travelocity have massively reduced the search costs associated with booking
airline tickets. By aggregating the various ticket prices into a convenient form,
time spent in searching for the best fare is reduced, and the opportunity costs of
travel arrangements are reduced. Effectively, travel has been made cheaper
due to information provided by a knowledgeable middleman.
Yet another fundamental of economic thinking is the concept of prices.
Prices constitute the central allocating mechanism of economics, and are the
decision-making parameters by which individuals organize their actions. For
example, consider the price of oil; literally millions of people use the price of
oil to make decisions affecting both business and personal consumer interests.
Large corporate firms use the price of oil to make important corporate
decisions regarding their own pricing (consider the airlines for example),
exploration and development activities depend upon the present price of oil,
numerous transportation decisions are related to the price of oil, and of course,
consumers alter their behavior based directly on the price of gasoline and oil.
In many instances, individuals are hardly aware of the impact that prices have
on their decision-making process since prices can be implicit as well as
explicit. In the case of the oil prices mentioned above, prices are explicitly
given in the marketplace; however, there are also implicit prices that must be
considered in the economic way of thinking. As an example the price of flying
from Orlando, FL to Houston, is $254 by Southwest airlines, and the cost of
driving there is $99.91.! On the surface, it might appear far cheaper to drive.
However, the true price of driving does not take into account the cost of 14
hours and 53 minutes of the passenger’s time. Assuming a median income of
$53,207 in 2011 (US Census Bureau, 2011), which translates roughly into
$26.60 per hour, the true price of driving is $372.40 + $99.91 = $472.31,
which makes it 84.8 percent more expensive than flying. Therefore, when the
implicit price of driving is considered, flying would be the more efficient
alternative.

SCOPE OF ECONOMICS
If we read different books on economics, we would see many different
definitions for the subject, but they all share two factors. First, there is the
notion of scarcity and second, the idea of unlimited wants. So we can define
economics as the art or science of using limited productive resources such as
land, capital, labor, and technology to produce different goods and services to
satisfy unlimited human wants. At its core, economics involves choices and
tradeoffs; choices matter because resources are limited while human wants are
unlimited. The economic method of thinking centers on analyzing the decisions
of individuals and the movements of markets in light of incentives and choices.
Economics has many subdivisions and specialties, but the broadest distinction
has been between “macro” and “micro” economics. These respective fields
are covered in the following pages.

Microeconomics

Microeconomics deals with the behavior of individual households and

businesses (decision-making units). It depends heavily on the concepts of
supply and demand; that is, the way in which the market determines the price of
goods and services and the level of production. Airlines provide particularly
good examples for the decision-making aspect of microeconomics since they
respond swiftly to changing market conditions by altering supply and/or prices
by utilizing sophisticated pricing techniques. Capacity (quantity) management
is a good example of microeconomic decisions. Some cases follow: during the
Gulf War airlines experienced a significant decline in traffic so they reduced
their capacity (supply) by 10 percent over a period of about one year. In India,
the low-cost carrier (LCC) JetLite Airways, a subsidiary of Jet Airways,
slashed fares on all sectors by up to 40 percent to increase quantity demand.”
Airline revenue management is another good example of a microeconomic
decision-making. Airbus and Boeing are two tough rivals in the aircraft
industry; they compete with each other to capture a bigger market share by
introducing more efficient aircraft.

Pricing decisions Based on pricing, businesses can forecast what a consumer

may buy, and how many units of that product or service will be sold. Revenue
management will be explored in greater detail in a subsequent chapter, but the
basic concept is that airlines price seats differently according to several
variables including service level, time before flight, and day of the week. The
idea is to charge each consumer the maximum he/she is willing to pay based on
his/her personal characteristics. The business traveler with little flexibility and
last-minute travel needs would intuitively be willing to pay a great deal more
than the casual vacationer who is much more price sensitive. Airlines separate
the aircraft into cabins (economy, business, and first in the typical three-class
system) that are further separated into classes, each with its own price point
and often slightly different ticket characteristics like flexibility and
refundability. Pricing the cabins according to classes allows the airline to
maximize its revenue based on traveler preferences, since it can charge a
higher price to those who are willing to pay it, and use them to cross-
subsidize, in a sense, those who would be much more price sensitive. The
entire exercise of revenue management is predicated on microeconomic
decision-making—travelers with certain characteristics are likely to support a
higher price than others, and pricing according to those characteristics benefits
both the airline and the consumers.
Decisions including aircraft acquisition, fleet selection, and route planning
are all microeconomic decision-making activities. Will this new aircraft have
a justifiably high load factor if employed on this route? Given route
characteristics, will adding this new aircraft to the fleet result in an optimal
mix? Is there a large enough market on this route to support the entrance ofa
new airline? All these decisions are based on the behavior of individual
consumers, and the effect that changing certain variables will have on
individual choices.

When an airline purchases or leases an aircraft, the airline economists evaluates the opportunity cost. You
buy one aircraft at the expense of another. Management usually purchase or lease the aircraft that will
give them the most value for the available resources.

Output decisions Output decisions for an airline often come in the form of
capacity decisions, aircraft size, aircraft type, and schedule selection. Capacity
decisions fall under the umbrella of microeconomic decisions; in recent years
airlines have shifted capacity away from domestic US markets to more
profitable international markets. In April of 2008, Emirates Airline started
New York service with a double-deck aircraft, but pulled it two months later
and replaced it with the smaller Boeing 777. In response to soaring fuel costs,
Frontier cut one-third of its daily departures from Milwaukee, from 67 to 45.
In addition, non-stop service to six cities was suspended.’ In May 2011,
Ryanair announced a capacity cut by grounding 80 aircraft in the winter
schedules between November 2011 and April 2012 due to the high cost of fuel
and continuing weak economic conditions.* Ryanair clearly focused ona
strategy that is low in cost structure, which allowed them to charge low fares.

Choice and opportunity cost Choosing to utilize a resource has an implicit

cost referred to as opportunity cost. As mentioned, opportunity cost can be
defined as the true cost of using a resource, which is the benefits that could
accrue if the resources were not being utilized in the current allocation. In
other words, the next best use of the resource is the true cost of using it. This is
why it may be efficient for executives to outsource their travel arrangements to
their executive assistant. The opportunity costs of the assistant’s time are less
than the executive’s—the latter could be better employed in running the
company and generating profits. Based on their relative opportunity costs,
executives can perhaps spend ten minutes searching for a ticket before the
opportunity costs of their time exceed the potential benefits. The Executive
Assistant can spend 30 minutes at the same task because of lower opportunity
costs and therefore has a better chance of finding a better deal.
Macroeconomics”

In contrast, macroeconomics studies the decision-making process for the entire

economy. Movements in gross domestic product (GDP), interest rates, inflation
rates, exchange rates, balance of trades, and their interrelationships are all
considered macroeconomics. In contrast to microeconomics, macroeconomics
is a field that comes into play during the decision-making of airlines and
aircraft manufacturers as a structural variable; that is, one which presents
circumstances and parameters which they may not be able to influence, but
need to take into account. For instance, movements in GDP and economic
activity have implications for travel—the microeconomic decisions made by
individuals are impacted by the overall economy, and the airline or airport
manager has to take into account these circumstances while making decisions.
Ina slow economic climate for instance, introducing discounted fares or sales
promotions might be more effective strategies at generating demand than
introducing a new luxury class. Airport and airline managers have to deal with
seasonality as well—travel is typically slow in the winter months, but picks up
during the holiday season, and prices may have to be altered to account for the
effects. Similarly, the impact of taxes and passenger fees on airline tickets is a
macroeconomic variable the airlines have to contend with. According to the
MIT Ticket Tax Project, 16 percent of the ticket price of an airline ticket is
determined by macroeconomic variables that the airline has to take into
account in terms of pricing and the price sensitivity of customers.
For aircraft manufacturers, macroeconomic variables become crucial in
terms of predicting the demand for aircraft over the long term, since the
financial health of airlines is highly dependent on economic cyclicality.
Therefore, forecasting when the demand for aircraft is likely to fall off and
pick up again will determine the timing of expected cash flows on aircraft, and
consequently, the breakeven year and quantity that will determine project
success or failure. In general, macroeconomic activity can be best understood
in terms of business cycles.

Inflation Inflation can be simply defined as the rise in prices of goods and
services in an economy over time. In order to measure inflation, the Bureau of
Labor Statistics (BLS) uses several indexes designed to measure the various
components of inflation. The Consumer Price Index (CPI) is a measure of the
average change over time in the prices paid by urban consumers for a market
basket of consumer goods and services. CPI measures the cost of goods and
services to a typical consumer, based on the costs of the same goods and
services at a base period. The CPI is published monthly by BLS. Furthermore,
the US BLS regularly reports the Producer Price Indexes (PPIs). PPIs are a
family of indexes formerly called Wholesale Price Indexes that represent the
change in the selling prices received by manufacturers of goods and services.
These indexes are primarily used to carry out price adjustments.

Unemployment Using the BLS’s classifications, a person is considered

unemployed if they do not have a job, have actively looked for work in the
prior four weeks, and are currently available for work. Persons who were not
working and were waiting to be recalled to a job from which they had been
temporarily laid off are also included as unemployed. The unemployment rate
represents the number unemployed as a percent of the labor force. The labor
force is the number of persons in the economy who have jobs or are seeking a
job, are at least 16 years old, are not serving in the military, and are not
institutionalized. In other words, the labor force is all people who are eligible
to work in the everyday US economy.

Number of Unemployed
Unemployment Rate =
Total Labor Force

Assume 2,000 people are unemployed in a small city with a population of

60,000 people, 48,000 people in the labor force, and 46,000 people are
employed. Hence, the unemployment rate is calculated as follows:
4
Unemployment Rate = A
48, 000
Unemployment Rate = 4.12%

Unemployment can be further classified as natural unemployment, cyclical

unemployment, and frictional unemployment.

Natural unemployment The natural rate of unemployment is the inherent rate

that will occur in an economy, separate from unemployment occurring due to
business cycles. The natural rate is determined by the rate at which jobs are
simultaneously created and destroyed, the rate of turnover in particular jobs,
and how quickly unemployed workers are matched with vacant positions. The
Congressional Budget Office forecasts the natural unemployment rate of the US
to be 5.0 percent through to 2017.

Cyclical unemployment Cyclical unemployment is another class of

unemployment, and refers to the unemployment that occurs as a result of
business cycles. As businesses go through their cycles, cyclical unemployment
occurs; when the business cycle is at its peak (maximum economic output),
cyclical employment is low. Cyclical unemployment occurs when consumer
expenditure is low and there is not enough demand for employers to hire
everybody who wants a job.
Similarly, when the business cycle is low and economic output decrease,
cyclical unemployment increases.

Frictional unemployment Frictional unemployment is also referred to as

transitional unemployment. This form of unemployment is always present in the
economy as a result of persons transitioning between jobs and new workers
entering the labor force. Frictional unemployment is therefore a function of the
time it takes the labor market to match the available jobs with persons in the
labor force. From an economic point of view, a business cycle is defined as
the movement of economic activities such as unemployment, inflation, and
economic growth and it is divided into four stages:°

e Expansion or recovery: Historically, the annual growth in air travel

has been about twice the annual growth in GDP, with increased growth
during periods of economic expansions.
¢ Peak: The peak occurs at the highest point between economic
expansion and the start of economic contraction.
¢ Contraction or recession: Contractions (recessions) start at the peak
of a business cycle and end at the trough and are marked by a significant
decline in economic activity spread across the economy, lasting more than
a few months, normally visible in real GDP, real income, employment,
industrial production, and wholesale—retail sales.
* Trough: The trough signals the end of a period of declining business
activity and the transition to expansion. This is the beginning of economic
recovery.
THE ROLE OF ECONOMIC SYSTEMS
Broadly speaking, modern political systems can be characterized by the
perceived role of the market and the prevalence of government in decision-
making and resource allocation. At one end of the spectrum there lies
hypothetical laissez-faire capitalism, which would be an economy driven
purely by the market with very little government involvement and where the
market dictates resource allocation.
On the other end of the spectrum, there lies a pure command economy,
where resources are allocated with reference to a central authority or a
government, with no reference to a market. In the middle of the continuum is a
mixed economy. The mixed economy is a combination of private enterprise
with a larger government sector (usually involved with income transfer) and
the existence of freedom of ownership, pricing policy, and profit earning,
Historically, no economies have ever achieved either extreme. The
beginnings of the post-industrial revolution US in the nineteenth century was
close to pure capitalism, although there was still some government
involvement in the economy. The Soviet Union’s communist economy for the
better part of the twentieth century was very close to a complete command
economy, although some market forces did exist in the form of black markets.
Over time, however, every modern economy has come to some form of mixed
system, some relying more heavily on government involvement than others.
Within every economy, there are industries that are subject to more or less
government supervision. Industries like the financial sector have historically
been subject to less regulation than manufacturing, pharmaceuticals, or
aviation. Therefore, while the US might have less government involvement in
economic activities than France, the aviation industry in the US might have
more industrial regulation than is average for the country as a whole, although
such regulation might be less than the regulation of the aviation industry in
France.
Further, even within the aviation industry, there will be more or less
regulation. For instance, the airline deregulation in the 1970s brought airlines
firmly within the sphere of the free market. However, simultaneously, aircraft
manufacturing and certification has grown more highly regulated over time, due
to liability concerns. Further still, different parts of the aviation industry might
be regulated differently. In Europe, for instance, airports are beginning to be
privatized, while the same is not taking place to that extent in the US.
Therefore arguably, airports in the US are subject to greater regulation than in
Europe, while the opposite is true for operational restrictions due to
environmental and noise concerns.
Increasingly, however, the push has been toward less government
involvement in aviation. For instance, the various open skies agreements
between the European Union (EU) and US allow any airline in the US to fly
from any point in the US to any point in Europe. This EU-US Open Skies
Agreement was first signed on April 2007 and became effective in March
2008. A second phase of the agreement aimed at reducing further barriers in
the transatlantic aviation market was signed in June 2010. This reduces the
involvement of governments in the decisions of individual carriers to offer
transcontinental service, and allows for increasing competition between
airlines in different countries. However, this agreement is by no means
comprehensive, as it does not allow any European carrier to operate flights
within two points in the US, while it allows American airlines to operate intra-
European flights. There have been drives to create a completely open skies
agreement between the two entities, which would represent a significant
withdrawing of government influence in air transportation.
An economic incentive is best described as a force or circumstance that
encourages an individual to engage in a particular activity. For instance, a tax
credit on home ownership will incentivize a certain kind of economic activity,
specifically, home ownership. Similarly, the emergence of LCCs and a
competitive threat incentivized the legacy carriers like American Airlines to
become more competitive and adopt practices like revenue management, which
drove ticket prices lower. In contrast, a disincentive is an incentive that
discourages an individual from engaging in a particular activity. Raising the tax
on jet fuel would necessitate higher ticket prices for the consumer as a result of
cost pass through, and give consumers a disincentive for air travel.
Incentives can be both economic and noneconomic in nature: the threat of
litigation has incentivized the Federal Aviation Administration (FAA) to
institute ever more stringent tests for aircraft certification, which has in turn
dis-incentivized many general aviation manufacturers from major or frequent
innovation. The Economic Way of Thought centers on analyzing incentives and
predicting human behavior when dealing with clearly defined incentives.
Incentives are a powerful tool for analyzing public policy. Phrasing things
in the language of incentives has the effect of throwing light upon the
consequences of policy and regulations: while airline regulation allowed
airlines to make a normal profit and enjoy stable operations, it incentivized
inefficient operations since no matter how low the load factor on approved
routes, they always generated a relatively predictable amount of costs and
revenues. While airline deregulation may have caused airlines’ operational
structures to become unpredictable, their revenue to fall, and their costs to rise,
it in turn incentivized competition, highly efficient operational practices like
revenue management and route profitability analysis. As a result, airline
consumers reaped the benefits of such operations in terms of new routes, new
airline options, and vastly lower ticket prices. We will return to airline
regulation and deregulation later in this chapter as an example of government
involvement in aviation.

Government and aviation

Throughout the world, aviation has always been deeply intertwined with
government. Since the beginning of commercial aviation in the 1920s and
1930s, governments on both sides of the Atlantic supported and subsidized the
fledgling industry, encouraging innovation through lucrative mail contracts, and
later through military contracts. The economics of early commercial aviation
were extremely unattractive—without the possibility of night flights or flying
through clouds or over weather phenomenon, with speeds of 90 miles an hour
at best, commercial aviation in the early 1920s was hardly viable without
government subsidies (Heppenheimer, 2001). In Europe, this took the form of
direct government subsidies to aviation. Both France and Germany laid the
foundations for their aviation industry with flag carriers Air France and the
Deutsche Luft Reederei, which would later become Lufthansa.’ The American
and British governments were more cautious about direct government support
—instead, they took the route of indirect subsidies through mail contracts. We
see this pattern to this very day, with the styles of support afforded to Boeing
and Airbus by the respective governments in America and Europe—both are
subsidized, albeit through different mechanisms. Airbus is arguable subsidized
more directly, while others argue that Boeing receives an indirect cross-
subsidization through its defense contracts.
Aircraft and engine manufacturing, on the other hand, had been receiving
government subsidies through direct contracts with the military since the First
World War, with many of the developments in aircraft design conducted by
Boeing, Lockheed Martin, McDonnell Douglas, Fokker, De Havilland, and
Northrop. The Contract Air Mail Act of 1925, and the subsequent Air
Commerce Act of 1926, had two important effects—first, they put commercial
aviation squarely into the hands of the private sector, but offered it massive
government support and reserved the power of regulatory oversight in the
determination and disposition of those contracts. It was under this umbrella
that commercial aviation would truly come into its own—monoplane design
for higher cruise speeds which would enable air mail to become an attractive
competition to traditional mail routes. Lockheed’s famous Orion and Vega, and
Boeing’s Monomail were all developed to maximize the profits that could be
had by the efficient transportation of government mail. Since the airmail
subsidies were based on weight, the greater the capacity of the airplanes and
the greater their useful load, the more money an airline could potentially make
from it. This had two effects—first, it shifted significant amounts of mail traffic
from railroads onto airplanes. Secondly, it spurred manufacturer/airlines to
focus on building and operating airplanes that could deliver the most weight
with the highest speed, leading to innovations in airplane design that poised
aircraft to take over high-speed passenger transportation in the future.
Yet another key piece of aviation legislation would take place with the
1930 Watres Act, championed by Congressman Walter Brown. Effectively, the
Watres Act changed the nature of the subsidies for air mail from weight to
mileage, which shifted the focus of aircraft manufacturers to build large planes
with an extended range, and effectively shifted the subsidy from freight to
passengers. Ifan airline was paid by the mile no matter what the weight of
mail it transported, it would want to fly aircraft which had long-range
capabilities, and incentivize intercontinental travel. Further, given that the
demand for mail was fairly static, and longer range usually necessitated larger
aircraft, it would have the incentive to use the extra space for the transport of
passengers. The government hoped that over time, successful airlines would
shift revenues from mail to passengers, and that the subsidies for the industry
could slowly be phased out. Further, the Watres act awarded the government
broad discretionary powers to award airmail contracts as they saw fit,
removing some of the competitive bidding associated with the mail contracts.
This was in line with Congressman Watres’s vision, which saw the
development of aviation in the US as being too chaotic. This consolidated the
competition in the airline industry into a few large players, setting the stage for
airlines that would eventually become known as the legacy carriers, and the
creation of the Civil Aeronautics Board (CAB). Therefore, the very inception
of aviation and the directions which the industry took were incentivized and
controlled by governments. The development of the commercial aviation
industry is an exercise in market responses to government incentives.
Increasing numbers of passengers and aircraft in the air created the need
for extensive infrastructure and an air traffic management system. The Federal
Airways Act of 1946 implemented key elements of infrastructure such as
navigational aids like the Instrument Landing System (ILS), Very-High-
Frequency Omnidirectional Range (the VORs), the designation of specific
airways used for navigation, and the increasing use of radar (Fried and Myron,
1997). The implementation of direct pilot to controller communication took
place in 1955. In 1959, airports were modernized under the direction of the
Federal Aviation Authority (created from the Civil Aviation Authority in
1958). The tragic midair collision at the Grand Canyon in 1956, where a
United Airlines DC-7 collided with a TWA Super Constellation while both
were operating under visual flight rules in uncontrolled airspace, prompted the
adoption of positively controlled airspace above 24,000 feet, and the
abandonment of visual flight rules by commercial airliners. Further regulation
was enacted in 1960 following a midair collision over Brooklyn that mirrored
the Grand Canyon accident of 1956. Therefore, aviation infrastructure,
navigational aids, airports, and aviation safety became tightly regulated, and
airlines would remain under the regulatory umbrella until 1975. Before 1975,
there were essentially four major airlines: United, American, Eastern, and
TWA. Pan Am was the largest international carrier. These airlines were
regulated by the CAB in terms of routes and fares, and new entrants had to
apply for permission to carry out air transportation, which could be contested
by the existing carriers. An airline wishing to expand service into a new route
had to fill out a petition with the CAB which would be open to dispute by the
existing carriers flying that route and could degenerate into full-blown court
proceedings. Every aspect of airline operations was regulated, right down to
new aircraft acquisitions, the type and disposition of freight carried, whether
carriers could issue refundable tickets, whether a carrier certificated to
operate a one-stop segment could change to non-stop service, whether the
flight attendants of two financially affiliated airlines could wear similar
uniforms, and so forth. Every operational detail of air transportation was under
scrutiny and required approval—and while on one hand, no carrier ever went
bankrupt under such regulation, neither did they have the flexibility to conduct
any business on their own terms without extensive approval processes.
 Arguably, it was airline deregulation that introduced the practice of
revenue management, which was a byproduct of competition engendered by the
emergence of LCCs. Revenue management, as discussed earlier, minimizes
consumer surplus by charging each consumer what he/she is willing to pay, as
opposed to a blanket single fare across consumer characteristics. Furthermore,
the fall in ticket prices and the increase in route choices points to a distinct
benefit. On the other side, airlines, especially legacy carriers, had to operate in
an environment of much more heated competition, with thinner margins and
potential price wars, with much the same cost and managerial structure they
had utilized during the days of regulation (Heppenheimer, 2001).
This pattern is by no means restricted to the US—every country has a
comparable aviation regulation framework, reflective of its economic and
political development. Throughout the world and in any political or economic
framework, aviation remains a tightly regulated industry with heavy
government involvement. The impact of government on various aspects of
aviation has shifted over time and tends to run in cycles. Recently, for example,
there has been a push for privatization of airports, especially in Europe, which
is triggering a similar call in America. Simultaneously, however, the costs of
certifying non-experimental aircraft have steadily increased over the past few
decades, although there has been an attempt to address this trend in the US
through the introduction of a new Light Sport Aircraft category that bypasses
most of the heavy certification and pilot licensure burden imposed on other
aircraft.
With this degree of government involvement, no discussion of aviation
economics would be complete without an analysis of the economics of
government, its incentives, and impact on commercial aviation. Governments
are a function of the political system and philosophy that each country has
come to adopt—the development of the FAA, airline regulation and
deregulation in the US and the historically unrestricted nature of general
aviation; all of these developments are intimately linked to the political
climate and prevalent philosophy at the time. In order to better understand the
nature of government involvement in aviation, it is necessary to discuss a
broader picture—market-driven political and economic systems in comparison
to command economies.

GOVERNMENT FAILURES AND MARKET FAILURES

Broadly speaking, there are two kinds of economic failures; market failures
and government failures. Market failure occurs when the market does not
allocate resources to their most efficient use, or equity failures, in which the
market does not allocate resources to their most—perceived—equitable
distribution. In this case the market would allocate more or less than optimum.
In economic market failures, the market is somehow not operating “as it
should.” The two main categories of market failures are externalities and a
lack of competition.
Externalities are hidden costs and benefits associated with the production
of a good or service that are not fully experienced by the individual producing
or consuming it, but exist as a byproduct of such production or consumption. A
negative externality is an undesirable consequence of production that is not
experienced directly by the producer, while a positive externality is a
desirable consequence that is a byproduct of production and also not
experienced by the producer. A classical aviation example of externalities
would be the congestion costs imposed by increased general aviation activity.
In the US, the number of active general aviation aircraft increased from
131,743 to 223,370 from 1970 to 2010 (BTS, 2010). General aviation traffic
does not pay user’s fees for their share of consumption of airport and air traffic
control resources. These are subsidized by the federal government, or in the
case of large airports, by the landing and other fees imposed on commercial
airlines. However, a high volume of general aviation traffic leads to increased
congestion at large airports, ties up air traffic control resources, and imposes
costs on all aircraft. If there were user’s fees for general aviation, and the pilot
experienced the full cost of his consumption of resources and the congestion he
creates by being airborne, the volume of such activity would drop off sharply.
Since the general aviation pilot only experiences a part of the true costs of
flying, he overproduces, in this case by flying a lot more than he would if he
were experiencing the full costs of flying.
Similarly, positive externalities exist when a remote city or rural area is
connected to the rest of the country by air travel. Apart from the revenues
generated by ticket sales to and from the area, the hidden benefits of air travel
include job creation from the airline and airports in the area, increased
possibilities for commerce and enterprise due to increased connectivity, the
possibility of emergency relief and aid in times of natural disaster, and so
forth. These externalities are not experienced by the airlines who seek to
provide service to the region—all they experience are low revenues and high
costs associated with operating in a thin market. Therefore, they under
produce, by choosing not to operate that route since it will have a poor
profitability. This is the role of the Essential Air Service Program, which
subsidizes such unprofitable routes due to the presence of substantial positive
externalities. The subsidies pass on some of the benefits of the positive
externalities to airlines, allowing them to operate in such thin markets.
The second kind of market failure is a natural lack of competition. Some
industries involve such a high level of fixed cost investment, high entry
barriers, and great economies of scale that natural monopolies are the only
sustainable firm structure. Large aircraft manufacturing is a good example of
such an industry. It cost approximately $14 billion to develop the Airbus A380.
The Boeing 777 cost approximately $5.5 billion to develop, and it had been
based on an existing product platform. This establishes high barriers of entry
into the industry and the economies of scale that are derived from mass-
production make sustaining vigorous competition extremely difficult. Further,
the uncertainty of the revenue stream is always extremely high. In other words,
even though the manufacturer might collaborate with its customers in designing
and building the aircraft, the volatile nature of the airline industry, the unstable
competitive structure due to bankruptcies, changes in economic circumstances,
and so forth make the end-revenues of a product extremely uncertain and raise
the cost of investment. Therefore, the manufacturing industry is dominated by a
few large players, and in order to keep the competition going, even if it
devolves into a duopoly, there needs to be a stable source of income in order
to effectively cross-subsidize the business of manufacturing large jets. In the
case of Boeing and Airbus, this takes the shape of government defense and
civilian contracts, as well as direct government subsidies. Many pundits have
argued that the commercial airports enjoy significant monopoly power and to
prevent monopoly profit, airport charges such as landing fees must be
regulated. Globally, many airports face little or no competition and without
regulation, they may charge monopolistic prices.
Government failure occurs when a government attempts regulation, but
does so inefficiently and the resulting allocation of resources is inferior to that
achieved by the free market. Airline regulation was an example of such a
failure. Though a case may be made for its benefit, it has been shown in
numerous studies like the US General Accounting Office studies (1996),
Morrison and Winston (1995), and Goetz (2002) that average airline fares
have declined through small, medium, and large airports since deregulation,
due to competition engendered by the emergence of LCCs. The US General
Accounting Office Study (1996) from their sample of 112 airports across the
US noted that airfare declines have been observed in 79, or 70.5 percent of
airports between 1978 and 1998. In real terms, passenger yield has fallen
nearly 40 percent in small airports from 1979-2008, 12 percent in medium
airports, and 20.6 percent in large airports. Economically, the decline in
passenger yield has not been nearly so pronounced in large hub airports
compared to small airports because of the hub premium. Most large airports
are dominated by one major carrier, with monopoly or near-monopoly pricing
power. Therefore, the premium associated with a hub airport is nearly always
greater than the premium associated with smaller airports in terms of
passenger yield. Arguably, small community airports have benefited the most
from deregulation in terms of passenger yield. Further, the total number of
scheduled departures in small, medium, and large hubs has also generally
increased, as Figure 2.1 demonstrates.
However, studies like Brenner (1988) and Anderson, Gong and
Lakshmanan (2005) have found decreasing competition in the airline market
due to bankruptcies and consolidations, as well as deteriorating competition in
major hub airports as a result of the dominance of major hub airlines. While
this trend was indeed the case through the first 20 years of deregulation, the
hub dominance of airlines like Delta at Atlanta was slowly eroded over time.
Delta’s market share at Atlanta (percentage of scheduled revenue passengers
enplaned through Delta as a percentage of total scheduled revenue passengers)
rose from 49.8 percent to 83.6 percent from 1977 to 1993, and has fallen to
63.2 percent in 2011 (see Table 2.1).® This is primarily due to the emergence
of viable competitors like AirTran that is now responsible for over 17.1
percent of the market share at Atlanta. Therefore, it may be argued that in the
long term, airlines return to a more or less competitive state in a deregulated
environment, as a result of the threat of new entrants, the lowered entry
barriers, and the accountability that is engendered through market forces.
 11,000,000

10,000,000 -

9,000,000
=

= 8,000,000 5
c
=i

& 7,000,000
a
6,000,000 -

5,000,000 lll lil

4,000,000 a iI ] |
5 SB os ab oh okt Dc PLS ag & Pag > ‘

Figure 2.1 Scheduled Departures within the US

Source: Compiled by the authors using Form 41

Table 2.1 Hub Dominance Before and After Deregulation: 1977, 1993, and 2011

L977 1993 2011

Ai sts Dominant Market Dominant Market Dominant Market

per Carrier Share Carrier Share (Carrier Share

ATL DL 49.9%, DL 83.7% DI 63.2%

CLI EA 74.9% US 8% Ls ee

CVG DL 35.1 DL 90.2% DL 37.8

DEN UDA 32.4% UA 52.6% UA 24.3

DIw DL 213 NW 79.1 I 445°

MEM DI 405 NW 76.6% DI 34.1'

MILA EA 30.6% AA 60.0% AA 69.3

MSP NW 46.3% NW 83.8% DL 50.1%

PIT Us 45.7%) us so.4% Sw 19.4

SLC WA 40.0% DI 747 DI 42.7

STI TW 39.5%, TW 61.4% WN 45.4"

Source: Back Aviation O&D Lux data and Bureau of Transport Statistics 2012

Yet another argument against deregulation is that airline bankruptcies since

deregulation have increased dramatically, since no airline was allowed to go
bankrupt under the CAB’s fares and competitive strategies. As of April 2012,
there have been about 47 airline bankruptcies in the US, among these 17
airlines ceased operations. According to a US General Accounting Office
Study in 1996, quality of service indicators have emerged with mixed results at
various airports across the US. Therefore, was deregulation a government
success or failure? It seems to depend on one’s perspective. Air travelers
today enjoy a greater choice of carriers, a greater number of routes from which
to choose and lower fares, all of which point to greater competition in the
airline industry. On the other hand, airline profitability has fallen considerably,
as have the compensation of employees. However, taken in its entirety, airline
deregulation may be said to be a government success—or rather a success of
the free market over the organizational power of the government in aviation.

“American will ground some planes and resize our network.”

Thomas Horton, AMR, CEO
After Filing for Chapter 11 bankruptcy, 2012

A more unqualified government success in terms of effective regulation is

the field of aviation safety. Since the creation of the FAA in 1958, accident
rates have dropped almost 92.5 percent, from approximately one every 12.5
million aircraft miles to one in every 166.67 million aircraft miles flown.
Figure 2.2 shows the dramatic decline in air traffic accidents between 1960
and 2010. Extensive regulations in terms of pilot certification, training, aircraft
airworthiness, operational directives, the institution of controlled airspaces,
navigational aids, sophisticated weather and flight planning tools, and the
standardization of scheduled air carrier operations has contributed to this
decline, which has contributed considerably to the development of aviation by
establishing an excellent track record for safety and accountability.
It may also be argued that much of this decline in commercial aviation
accidents and fatalities is attributable to factors other than government
regulation—the introduction of jet engines, for instance, improvements in
avionics instituted by the private sector, improvements in pilot training, the
rise of simulators as a flight-training tool—these are factors that could have
arguably arisen even without government regulation. However, regardless of
the relative percentages of aviation safety attributable to the market or the
government, the dramatic decline in aviation accidents and fatalities since the
1960s, coupled with strong regulatory pressures on airlines and aircraft
manufacturers to emphasize safety presents a remarkable example of the
government and the market working in tandem to achieve an optimal result.

SUMMARY
This chapter introduces the reader to the economic way of thinking in the
context of aviation. We presented economics as a science of choice amidst the
scarcity of resources, and the concepts of incentives and opportunity costs
which are fundamental to economic decision-making. We gave several
examples of incentives and opportunity costs at work in the form of travel
agents and aviation tax credits. We then presented the differences between
microeconomics and macroeconomics, and how each might affect aviation
managers in terms of variables they could control, and variables to which they
had to devise an optimal reaction. We went on to present the role of
government in an economy as a spectrum of government influence. On one
extreme, we have laissez-faire capitalism with no government influence. On
the other, we have a command economy in which the allocation of resources is
entirely conducted by the government. Most modern economies throughout the
world lie somewhere in between those two extremes; presenting a mixture of
market-driven and government-regulated allocation of resources. We went on
to show that even within a given economy, government influence is non-
uniform, with some industries being more highly regulated than others, and
even within an industry like aviation, some aspects—such as airline operations
—are less highly regulated than aviation safety. We gave a brief history of
government in aviation, noting that the industry has been intertwined with
government since its inception and presenting macroeconomic and regulatory
variables as extremely important decision-making inputs for the aviation
manager. We analyzed government and market failures, examining the aircraft
manufacturing industry as a market failure due to the high entry barriers that
naturally restrict competition, and airline deregulation, as an example ofa
market success, where the FAA had removed restrictive regulation for the
betterment of the industry. We mentioned aviation safety as an example of
regulatory success, noting that while regulation might have had a significant
impact on the falling accident rates, much of it may also be attributable to
natural market forces such as emerging technologies. Having established the
fundamentals of economic thought, the following chapter will focus on supply
 and demand, prices, and equilibrium in order to explore the implications and
interpretations of this analysis in the context of aviation.
50

45
Fatality Rate per 100 million

40

35
aircraft miles

30 +

70

15
10

€
O06

OOK

O10
O04
*
]
]
]
]
]
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5
5
x
-
Figure 2.2 Accident Rates per Million Aircraft Miles Flown: 1960-2010
Source: BTS National Transportation statistics, Table 2.9: US Carrier Safety Data

DISCUSSION QUESTIONS
1. Explain what the concept of opportunity cost means in economics.
2. How do individuals and firms generally make decisions concerning
economic situations?
3. Give a standard definition of the science of economics.
4, What are the main differences between micro and macroeconomics?
5. How does the chapter classify government control of the economy?
6. List two types of perceived market failures.
7. What are some of the main problems associated with total government
regulation of the aviation industry?

REFERENCES
Anderson, W. G. (2005). Competition ina Deregulated Market for Air Travel: The U.S. Domestic
Experience and Lessons for Global Markets. Research in Transportation Economics, Vol. 13, 3-25.

Brenner, M. (1988). Airline Deregulation: A Case Study in Public Policy Failure. Transportation Law
 Journal, Vol. 16, No. 2, 179-227.

Bureau of Transportation Statistics (BTS) (2010). Number of US Aircraft, Vehicles, Vessels, and Other
Conveyances, pp. Tables 1-11. Retrieved on May 13, 2012 from
http://www. bts.gov/publications/national_transportation_statistics/html/table_01_11.html Last
accessed August 16, 2012.

Colander, D. (2004). Microeconomics. New York: McGraw-Hill.

Fried, W. and Myron, K. (1997). Avionics Navigation Systems, 2nd ed. New York: John Wiley & Sons.

Goetz, A. (2002). Deregulation, Competition, and Antitrust Implications in the US Airline Industry.
Journal of Transport Geography, Vol. 10, No. 1, 1-19.

Heppenheimer, T. (2001). Turbulent Skies: The History of Commercial Aviation. New York: Sloan
Technology Series.

Hirschey, M. (2006). Managerial Economics (11th ed.). Mason, OH: South-Western.

Kane, T., Holmes, K. and O’Grady, M. (2007). 2007 Index of Economic Freedom. Washington, DC: The
Heritage Foundation.

McGuigan, J., Moyer, R. and Harris, F. (2008). Managerial Economics: Applications, Strategies, and
Tactics (11th ed.). Mason, OH: South-Western.

Morrison, S. (1997). Airline Deregulation and Fares at Dominated Hubs and Slot-Controlled Airports.
Hearing before the Committee on the Judiciary United States House of Representatives.

Morrison, S. and Winston, C. (1995). The Evolution of the Airline Industry. Washington DC: The
Brookings Institution.

US Census Bureau (2011). Income, Poverty, and Health Insurance Coverage in the United States.
Retrieved on August 16, 2012 from http://www.census.gov/prod/2011 pubs/p60-239. pdf.

US General Accounting Office (1996). Airline Deregulation: Changes in Airfares, Services, and
Safety at Small, Medium-sized, and Large Communities. Washington DC: US General Accounting
Office.

Vasigh, B. and Haririan, M. (2003). An Empirical Investigation of Financial and Operational Efficiency of
Private Versus Public Airports. Journal of Air Transportation, Vol. 8, No. 1, 91-110.
 1 Retrieved from Southwest.com on October 11, 2009, for travel on October 19, 2009 assuming fuel
burn of 24 miles per gallon, and a gas price of $2.50 per gallon.
2 Oasis Hong Kong Airline was launched in 2006 and is a now-defunct long-haul low-cost airline.
3 Airlines cut flights as jet-fuel costs climb. Denver Post, October 24, 2011.
4 The Financial Times, Ryanair to cut capacity for first time, May 23, 2011.
5 Macroeconomics will be discussed in much greater detail in Chapter 14.
6 Duration of periods and contractions can be found from a variety of sources including the National
Bureau of Economic Research.
7 Deutsche Lufthansa timetable at timetableimages.com.
8 Bureau of Transportation Statistics 2012—Airport Snapshots and Market Shares.